In Short
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Directors’ Personal Liability: While companies are separate legal entities, directors can be personally liable for company debts if they provide personal guarantees or engage in insolvent trading.
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Insolvent Trading Risks: Allowing a company to trade while insolvent breaches directors’ duties and can lead to personal liability for incurred debts.
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Legal Consequences: Breaching directors’ duties may result in civil penalties, compensation orders, or criminal charges.
Tips for Businesses
As a director, regularly monitor your company’s financial health to ensure it can meet its debt obligations. Avoid providing personal guarantees unless necessary, and seek professional advice if your company faces financial difficulties. Understanding your responsibilities can help prevent personal liability.
A limited liability company is an independent legal entity. Therefore, if someone sues the company, they are suing the entity, not its directors or shareholders. However, there are some circumstances in which a director may be held personally responsible for a company’s debts and liabilities. In that case, they may need to use their personal assets and finances to pay the debts the company owes.
Importantly, be aware of the measures in place by the Australian Government and the Australian Securities and Investment Commission (ASIC) that hold directors responsible for their actions. This article details the circumstances in which you, as a director, may be personally liable for a company’s debts. It also outlines how to manage liability risk to avoid being personally responsible.
Liability as a Company Director
Before consenting to act as a director, it is essential to understand how long you owe obligations to the company. Once a company is registered, the rights and liabilities of each director will continue. They will continue until, and in some circumstances after, that director resigns and/or the company has finished trading or has been deregistered. Therefore, keep this in mind in light of any debts incurred by your company when acting as a director.
Liability Under a Guarantee
As a director, you can be personally liable if you have signed a director’s guarantee. This is also the case if you have provided security over your personal assets for:
- loan;
- credit facility; or
- other agreement in the interest of your company.
A director’s guarantee operates in the same way any other personal guarantee does. You personally agree to pay a company debt if the company defaults on its obligation to do so.
It is important to note a guarantee against a director cannot be enforced without leave of the court during a period of voluntary administration. The purpose of voluntary administration is to investigate the company’s affairs and decide what strategy is in the best interests of the company’s creditors. If a guarantee was allowed to be immediately enforced during this process, the purpose of voluntary administration would not be achieved.
However, the voluntary administration process does not halt proceedings already on foot. Nor does it stop a creditor from enforcing a judgment that the court has already handed down.
Continue reading this article below the formTrading While the Company is Insolvent
You may be personally responsible for losses that your company incurs due to a breach of your directors’ duties in the Corporations Act 2001 (Cth). For instance, if you have caused or permitted the company to incur debts after it has become insolvent. Specifically, this is a breach of the duty not to trade while the company is insolvent. Breaches of the directors’ duties can lead to civil and criminal penalties under the Corporations Act.
To be liable for insolvent trading, there must be reasonable grounds for you, as a director, to have suspected the company is insolvent or would become insolvent as a result of incurring the debt.
If you are a company director, complying with directors’ duties are core to adhering to corporate governance laws.
This guide will help you understand the directors’ duties that apply to you within the Australian corporate law framework.
Case Study
An example of a company director being personally liable for insolvent trading is ASIC v Edwards. Murray River Pty Ltd (MRL) entered into an agreement for building works with Colin Joss & Co Pty Ltd (CJC). MRL was insolvent when CJC performed the building works for MRL.
The court found reasonable grounds for MRL’s director to suspect that the company was insolvent during the period in which CJC carried out the works. Ultimately, MRL disadvantaged CJC as they did not have the money to pay for CJC’s work. Therefore, the director was disqualified from managing corporations for 10 years for breaching his duty under the Corporations Act.
Defences
There are defences to insolvent trading. These include:
- whether you had reasonable grounds to expect the company was solvent at the time the company incurred the debt and would continue to be solvent;
- whether you took reasonable steps to prevent the company from incurring the debt; and
- if you did not participate in the company’s management at the time the company incurred the debt due to illness or another legitimate reason.
Illegal Conduct
Engaging in Phoenix Activity
The term ‘illegal phoenix activity’ refers to fraudulent activity which involves a director transferring company assets to another entity and continuing to operate the business, and then putting the old company into administration or liquidation to avoid paying creditors or employees.
If you engage in illegal phoenix activity, you can be personally liable for a breach of the director’s duties. You may then be disqualified from managing corporations in the future.
Enforcing Compliance
The introduction of the Director Identification Number (DIN) aims to combat illegal phoenixing activity. The Australian Government is taking additional steps to ensure all Australian company directors are responsible for their actions. The tracking system under the DIN regime means that each director must apply for a unique DIN, which they will keep permanently. Therefore, if you act as a director of multiple companies, it will be easy to identify you across those companies.
Liability Under Statutory Regimes
A statutory regime includes written laws that formally detail your legal obligations and consequences for non-compliance. Specifically, there are some statutory regimes under which a director can be personally liable for a debt. This can be either directly or as an accessory to an infringement of statute.
For example, as a director, you have personal liability for unpaid ‘Pay As You Go’ (PAYG) tax or Superannuation Guarantee Charge (SGC) amounts the company has not paid under the Australian Tax Office’s Director Penalty Regime.
Managing Your Risk as a Director
As a director, you can take several practical steps towards minimising your risk of personal liability whilst performing your role as a director. The most common ways to reduce risk as a director are as follows:
| Risk | Description |
| Maintaining proper documentation | Keep detailed records of all board meetings, decisions, and the reasoning behind them. This includes maintaining accurate financial records and ensuring all corporate governance documents are up to date. Good documentation can serve as evidence that you exercised reasonable care and diligence in your role. |
| Implement a system of regular financial health checks for your company | This should include: – a monthly review of cash flow projections; – regular monitoring of key financial indicators; – timely payment of tax obligations and superannuation; and – regular meetings with your accountant or financial advisor. |
| Don’t hesitate to seek professional advice when facing significant decisions or challenges | This might include: – legal counsel for complex contracts or regulatory matters; – financial advice for major investments or restructuring; and – industry experts for specialised operational decisions. |
| Keep yourself informed about your legal obligations and industry developments: | – attend director education programs; – stay updated on regulatory changes; – maintain membership in relevant industry bodies; and – network with other directors to share experiences and best practices. |
Implementing these strategies will provide you with the basis for protecting yourself as a director while fulfilling your duties as a director effectively and responsibly in the company’s best interests. For further information, LegalVision has produced a Directors Duties Guide, which you can access for free, that sets out the roles and responsibilities of corporate directors.
Key Takeaways
As a director, you can be personally liable for your company’s debts when things go wrong. It is important to remember that your liability may be ongoing and that you must always fulfil your duties as company director. Likewise, you must remain financially diligent and avoid trading while insolvent. Importantly, never engage in illegal conduct.
If you need help with your corporate governance obligations, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Once a company is registered, the rights and liabilities of each director will continue. They will continue until, and in some circumstances after, the company has finished trading or has been deregistered.
‘Phoenix activity’ refers to a fraudulent activity that involves a director transferring company assets to another entity. Following this, a director puts the old company into administration or liquidation to avoid paying creditors or employees.
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